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Introduction to Impact Investing – How can I become an impact investor?

In our latest blog, Anthony Randazzo discusses the concept of “impact” and what it takes to become an impact investor.

Friends and family sometimes ask me how they can become an impact investor. They love the idea of aligning their investments with their values and want their money to earn a financial return while generating positive environmental or social benefits.

However, the ability to become an impact investor depends on a number of factors, such the investment regulations where you live, how much money you already have, and most importantly, your understanding of the word “impact.”

This is because most social enterprises are still early stage ventures and so the opportunities to invest in them are concentrated in illiquid, private debt and equity markets. Few social enterprises have achieved sufficient size and scale to warrant an initial public offering of shares or a listing of corporate bonds. Some large microfinance banks have gone public and are listed in London (ASA International), Mexico (Compartamos), Frankfurt (ProCredit Holding) and Mumbai (Ujjivan, Equitas, BFIL), but these are exceptions. The primary constraint facing impact investors globally is a lack of publicly-traded, liquid securities in which to invest.

This is why the second issue, how much money you have, can determine what investment opportunities are available to you. Issuers of securities typically have to register with a securities regulator and issue a prospectus before making a public offering, which is an expensive, cumbersome and time-consuming process. This is why smaller, earlier stage companies typically make private placements of securities that are exempt from this requirement.

Such securities can only be offered to sophisticated investors who understand the risks. In the U.S. such investors are known as accredited investors (having a net worth over $1 million or annual income above $200,000) but similar definitions exist in Europe and other developed countries. This is why if you already have a lot of money, there are more options available to invest directly in companies or in investment funds targeting social enterprises. If you are of more modest means, however, your options are limited.

This is a real problem in the impact investing world because there’s a growing gap between demand and supply. Generally speaking, too many interested investors are chasing too few investable assets. Brokers, dealers, and money managers need listed securities with ratings, daily pricing, liquidity, and sufficient free float to offer their clients. This is understandable. Normally, such a mismatch might cause the price of available assets to go up. Instead what’s happening is new supply is entering the market via a process some call “impact washing,” i.e. labeling an investment as “impact” when it is not.

For example, investing in portfolios of publicly traded companies that have been selected according to certain positive environmental, social and governance factors (“ESG”) is commonly known as Socially Responsible Investing (“SRI”). By selecting the best performing companies, you minimize the negative impacts of your investment decision-making and reward those companies that demonstrate a positive ESG track-record. While personally I strongly support the concept of SRI investing, it is not the same thing as impact investing.

Unfortunately, many money managers and financial advisors are calling SRI investing “impact” in order to meet investor demand, which is creating confusion and blurring the distinctions between the two. If your goal is to do no harm, or to invest in companies with positive ESG ratings, then SRI is a good approach. Just keep in mind that this is not the same thing as investing in companies that address the root causes of poverty.

Does this mean that if you are not a sophisticated investor that you will forever be frustrated in your efforts to invest your money with environmental and social impact? Not exactly.

There are options available to achieve impact with your money without violating securities laws. My next blog will provide some practical suggestions for achieving real impact.

Anthony Randazzo, CFA is an impact investment professional with extensive experience working in emerging and frontier markets. He has devoted his entire career to the fields of international development and finance and has worked in the impact investing space since 2007. He writes on the subject of impact investing and is the creator of the Impact Money Blog, an independent source of insights on impact investing and social entrepreneurship (views expressed there are his own).